美國信安金融集團 (PFG) 2005 Q3 法說會逐字稿

Good morning, and welcome to the Principal Financial Group third quarter 2005 conference call. There will be a question and answer period after the speakers have completed their remarks. If you would like to ask a question at that time, simply press star and the number one on your telephone keypad.

I would now like to turn the conference over to Mr. Tom Graf, Senior Vice President of Investor Relations.

Thank you. Good morning, and welcome to the Principal Financial Group's quarterly conference call. If you don’t already have a copy, our earnings release and financial supplement can be found on our web site at www.principal.com/investor.

Following a reading of the Safe Harbor Provision, CEO Barry Griswell and CFO Mike Gersie will deliver some prepared remarks. Then we’ll open up for questions. Others available for the q and a are our three Division Presidents, John Aschenbrenner, responsible for the Life and Health Insurance segment; Jim McCaughan, responsible for Global Asset Management; and Larry Zimpleman, responsible for our U.S. and International Asset Accumulation. Julia Lawler, Chief Investment Officer, will also be available for questions.

Some of the comments made during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. There are a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Factors that could cause actual results to differ materially are discussed in the Company’s most recent Annual Report on Form 10-K and quarterly report on Form 10-Q filed by the Company with the Securities & Exchange Commission.

Barry.

Thanks, Tom. And welcome to everyone on the call.

As always, Mike will provide a detailed overview of the quarter’s financials. I’ll offer some performance highlights, then focus the remainder of my remarks on our continued strong progress in three key areas: accelerating growth in the U.S. and international retirement businesses, creating a successful global asset manager, and profitably growing our life and health insurance businesses.

For the three months we delivered near record earnings per share, continuing to build on strong first half performance. The third quarter contributed to 23% improvement in EPS YTD, positioning us to again exceed our long-term annual EPS growth target of 11% to 13%. While there were some unusual items benefiting the quarter, which Mike will discuss shortly, the strength of our performance overall reflects robust underlying growth in the majority of our businesses.

During the third quarter we delivered strong operating earnings of $214 million. This includes double-digit earnings growth in seven of our businesses: pension full service accumulation, mutual funds, individual annuities, principal global investors, principal individual life, and specialty benefits.

Our second best quarter of operating EPS at $0.75, a 14% improvement over a year ago and record assets under management of $188 billion, up $34 billion or 22% over the prior year quarter.

Through the nine months we’ve increased total Company operating earnings by nearly $80 million or 14% to $645 million. This reflects double-digit growth in our U.S. and international asset management and accumulation segments, as well as in our Individual Life and Specialty Benefit Division.

As communicated, in 2005 we remain highly focused on driving results in several critical areas. Let me start with our efforts to accelerate growth in our U.S. and international retirement businesses. Pension full service accumulation had an outstanding quarter, delivering 10% earnings growth from a year ago, as well as record organic sales, record fee revenues, and it’s strongest net cash flow quarter in more than two years, reflecting 28% growth in deposits.

Importantly, pension full service accumulation also achieved record account values, reflecting continued strong investment performance from principal branded retirement plans separate accounts. As of September 30th, 2005 81% and 73%, respectively, were in the top two Morningstar performance quartiles for the trailing 12-month and trailing 3-year periods. Compared to a year ago full service accumulation account values are up 25%. Mike will reconcile account value growth and operating earnings growth for the period. I’ll now provide a little more color on the key drivers of account value growth.

As I mentioned, we delivered record organic sales, $1.9 billion, an increase of 46% from a year ago as several larger cases closed in the third quarter. This clearly illustrates how significant the timing of planned sponsored decisions around effective dates is to our sales results, and the importance of analyzing sales growth over a longer period of time.

Through nine months full service accumulation sales are nearly $4.5 billion, up 17% compared to the same period a year ago. Based on our pipeline of fourth quarter effective date commitments we currently expect full year to come in between $5.8 and $6 billion. While still early, for 2006 we would currently target organic sales of $6.4 billion to $6.7 billion.

Our continued confidence around sales reflects our increasing strength in the marketplace as evidenced by higher sales through alliance partners and growing demand for our offerings. At $1.8 billion through nine months, alliance sales, a key driver of longer term growth, have more than doubled.

We’re also continuing to capitalize on the shift in demand toward total retirement solutions. The number of total retirement suite plans sold has more than doubled YTD, making up roughly 37% of total sales based on assets. Total retirement suite is not only resonating with larger cases but across all segments in our small to medium business target market.

We also continue to capitalize on opportunities in the small case market using security builder, with sales up 18% though nine months. In terms of full service accumulation net cash flow the third quarter came in at $1.3 billion or nearly 2% of beginning of year account values. This strong result positions us to achieve our 2005 mid-cash flow target of approximately $3.4 billion. As you will recall, in consideration of the impact of acquisitions such as ABN Amerow, we revised our long-term net cash flow target to 5% of beginning year account values.

To conclude the net cash flow discussion I’ll provide a quick update on integration of ABN Amerow on to our platform. At quarter end we were approximately 25% through the conversion, meeting or exceeding our acquisition assumptions. We expect to complete the conversion by March 2006. I would point out that while we are very pleased with this performance, there is still some uncertainty as to how net cash flow will emerge from that business over the next couple of quarters. As always, though, we’ll continue to focus on sales growth as well as improving contract level retention, participation and deferral rates. Additionally, our strong member level asset retention capabilities will help drive growth in net cash flow and earnings in our other retail businesses over time.

Moving to our international retirement businesses, significant growth in assets under management continues to drive strong revenue growth and strong growth in operating earnings. From a year ago, Principal International’s assets under management are up 62% to a record $14.7 billion. $1.8 billion of the growth relates to increased ownership in our Malaysian joint venture. Excluding that amount segment assets under management are up 42%.

I would remind you of an exciting development for Principal International during the third quarter, our entry into China. Through our joint venture with China Construction Bank, one of the best financial services brands in China, we expect to capitalize on opportunities to deliver mutual funds and potentially other financial services to the Chinese public.

We also continue to make outstanding progress in creating a successful global asset manager. Principal Global Investors again delivered exceptional investment performance with consistently strong performance in each major asset class. Notably, 89% and 80%, respectively, of the retirement plan assets managed by Principal Global Investors were in the top two Morningstar quartiles for the one and three-year periods. This compares to about 67% for both periods a year ago. All six lifetime accounts ranked in the top third of its category for the YTD 12-month and three-year periods.

Improved investment performance and an expanded portfolio of value added products have made Principal Global Investors increasingly search competitive for new institutional mandates. Through nine months we’ve won and funded mandates representing nearly $4.8 billion of assets, a 65% increase over the prior year. Compared to a year ago Principal Global Investors’ third-party assets under management are up $12 billion or 41% to $41 billion. This does not include a major win in the month of October. $900 million of additional U.S. real estate to be managed on behalf of [McQuarry Office Fund], an Australian REIT.

Outstanding growth in AUM and strong securitization results are translating into outstanding earnings growth. For the first nine months Principal Global Investors earnings are up 44% from the same period a year ago.

In terms of profitably growing our life and health businesses I would point to several key areas of progress with our growth initiatives. Specialty benefits premiums and fees, as well as sales, continued to increase strongly in the third quarter. Compared to a year ago both measures are up more than 15%, contributing to record operating revenues for the Division and the segment.

In the Health Division sales in our targeted states increased by 22% from a year ago. Total group medical covered members are up 4% from a year ago, driven by 11% growth in our target states. Third quarter 2005 was our third consecutive quarter of growth in the block and fifth consecutive quarter of target state member growth.

For the Individual Life Division insurance in force broke through the $100 billion mark during the third quarter, growing 8% over the prior year. While individual life recurring premium sales were down in the third quarter, YTD results have been very strong nearly matching outstanding performance for the first nine months of 2004.

Before I close, let me briefly cover a couple of other areas. In terms of effective use of capital, funding organic growth and strategic acquisitions remain our top two priorities. We are optimistic that consolidation of the DC market will continue. And, again, we intend to be a major player.

Let me also briefly discuss our outlook or 2006. We intend to communicate a range of EPS and net income per diluted share estimate in early December of 2005. This timing is a little later than we’ve done historically, reflecting a change in process which increases the Board’s involvement in reviewing our guidance estimates.

In closing, we’ll continue working hard to extend our leadership in the small and medium sized businesses and our employees. We’re confident that with further economic recovery and modest equity growth we’ll continue to achieve our EPS growth and ROE expansion targets and to deliver superior long-term results for our shareholders.

Mike.

Thanks, Barry.

This morning I’ll spend a few minutes providing additional highlights for the quarter and financial detail for each of our operating segments. We are very pleased with third quarter operating performance. As Barry indicated, we delivered strong total Company earnings. Coupled with effective capital management we achieved a 14% improvement in operating earnings per share compared to a year ago, a result that would have been even stronger if not for unusual items benefiting the prior year quarter, including reserve adjustments, favorable tax adjustments, and high investment prepayment fee income.

Moving to the segments, I’ll start with highlights for U.S. asset management accumulation. Segment assets under management increased $29 billion or 22% from a year ago driving total Company assets under management to a record $188 billion at quarter end.

As footnoted in our earnings release and financial supplement, we now count structured credit transactions at the amount funded by Principal Life for third-party investors, instead of at their underlying reference portfolio value.

At quarter end the structures managed by Principal Global Investors had underlying reference portfolio value of $6.4 billion, while the amount included in assets under management is approximately $230 million. We adjusted assets under management for all periods to reflect this change.

Compared to a year ago segment operating earnings increased 8% in the third quarter to $133 million. For nine months segment earnings are up 10% and segment fee revenues are up $148 million or 20%. Excluding full service payout results, which I’ll discuss shortly, segment earnings would be up 15% for the nine month period.

Pension full service accumulation was the second largest contributor to segment earnings growth behind Principal Global Investors, improving $5.5 million or 10% from third quarter 2004 to $63 million.

Through nine months full service accumulation operating earnings are up 12% to $186 million. This increase in earnings compares to a 21% increase in average full service accumulation account values over the same comparison period. As you will recall, the ABN Amerow block is at breakeven for 2005 on an operating earnings basis as we integrate it into our platform.

Excluding ABN Amerow average account values are up 14%. Normal minor variances in prepayment income, expenses, and income tax make-up the remainder of the difference, demonstrating that account value growth continues to be a reliable proxy for earnings growth.

The individual annuity and mutual fund businesses continue to make strong contributions to segment earnings growth, as well, improving 23% and 43%, respectively. Reflecting solid sales and good retention of at risk retirement plan participant assets, both businesses have achieved 20 + percent account value growth compared to the third quarter 2004. I would point out, however, that the flattening of the yield curve has reduced fixed deferred annuity sales, dampening sales growth overall with the individual annuity business.

Moving to Principal Global Investors, third quarter 2005 earnings were very strong at $18 million, up 65% from third quarter 2004. Through nine months Principal Global Investor’s earnings are up 44% or nearly $17 million. Higher earnings in both periods reflects strong growth in assets under management as well as increased commercial mortgage securitizations.

With the creation of [Principal Commercial Funding II], announced last week, we further enhanced our ability to grow commercial mortgage backed securitization business in the future, as we will no longer be constrained by our balance sheet. This business jointly owned by Principal real estate investors in U.S. Bank will focus on securitizing commercial mortgages originated by Principal real estate investors in U.S. Bank, on its behalf.

As I mentioned, segment earnings growth has been dampened by full service payout results. Earnings for the third quarter were down $2 million, primarily due to lower prepayment fee income. And earnings are down $11 million YTD primarily due to lower mortality gains compared to the same period a year ago.

While the low interest rate environment continues to depress the single premium group annuity market and our sales, we believe that as interest rates rise we will benefit from significant pent-up demand.

Investment only earnings were down $6 million in the third quarter, also largely due to prepayment fee income offsetting the $3.5 million or 7% improvement in investment only earnings through midyear.

Within International asset management and accumulation third quarter 2005 earnings grew to $20 million from $11 million in the year ago quarter. Excluding the impact of tax benefits on both quarters third quarter 2005 earnings would have been $19 million compared to $8 million in the prior year quarter, an increase of $11 million.

About two-thirds of this increase reflects improved operating performance, primarily our pension operations in Mexico and Brazil, driven by continued strong growth in assets under management. The increase also reflects refinements to accrued revenues in the Mexican pension businesses.

YTD unusual items added $5 million to segment operating earnings. Principal International’s earning have also benefited by $5 million YTD due to higher than normal returns from inflation linked investments. Excluding those items, Principal International has delivered about $38 million of earnings for the nine-month period which translates into more than 30% growth in earnings compared to the same period in 2004, reflecting strong performance along with the lower capital base as a result of the second quarter 2005 capital repatriation from Mexico, segment trailing fourth quarter return on equity reached 6.9%, a 240 basis point improvement from a year ago. While we will continue to experience some volatility and seasonality the segment remains on track to achieve a sustainable return on equity of 7% by 2007 and 10% by 2010.

Moving to the life and health insurance segment we continue to see very solid results overall, driven by strong sales and improving retention. Third quarter 2005 operating earnings were very solid at $65 million, compared to $72 million in the prior year quarter. Double-digit earning growth for the Individual Life and Specialty Benefits Divisions were offset by lower earnings in the Health Division. As previously communicated, third quarter 2004 segment earnings benefited by nearly $11 million due to reserve adjustments, including a $7 million adjustment in the Health Division.

Individual life earnings were $32 million for the third quarter 2005, up $6 million from a year ago. Excluding the negative impact of deferred policy acquisition costs unlocking third quarter 2004 earnings would have been approximately $29 million.

As in the second quarter the Division benefited in the third quarter 2005 from ongoing results of FAS 113 reinsurance methodology refinements, which we expect will contribute to future earnings volatility for the Division.

One other point regarding the Individual Life Division, as you know, final guidance has now been issued on the nonqualified deferred compensation provisions of the American Jobs Creation Act. We expect to see higher sales of executive variable universal life over the next few quarters, partially offsetting lower anticipated sales of our repriced universal life product with secondary guarantees.

Earnings for the Specialty Benefits Division were $18 million, compared to $14 million in third quarter 2004. This increase reflects continued strong growth in the business overall, as well as favorable claims experience, particularly in the group life line. Compared to the year ago quarter, as well as through nine months, all lines in the Division have delivered double-digit growth in premium and fees, reflecting strong sales and favorable retention.

Health Division earnings were $15 million in the third quarter. This compares to a record $32 million in the year ago quarter, which included a $7 million favorable reserve adjustment. The remaining variance in earnings between quarters primarily reflects higher than expected claims in the third quarter 2005 compared to better than expected claims in the prior year quarter. We believe this is just a one quarter fluctuation in experience. Importantly, we continue to make meaningful progress with our Health Division initiatives. Good growth in group medical premium and fees, solid momentum with our new high deductible health plan, and a significant increase in wellness lives.

Before taking questions, I’d like to provide an update on the accelerated repurchase program associated with our preferred stock issuance, as well as comment on the earnings impact of the third quarter preferred stock dividend. As you know, our accelerated share repurchase program is subject to a market price adjustment provision based on the volume weighted average market trading price over the execution period.

We currently expect the program will be fully executed by monthend, and we estimate we will pay a trueup adjustment of approximately $80 million given share price appreciation to date. In the second quarter we did not declare any preferred stock dividends, but in the third quarter preferred dividends declared reduced corporate segment operating earnings by $9.4 million. Clearly, in the near term the earnings impact of the preferred dividend substantially offsets the positive impact of lower weighted average shares outstanding on earnings per share.

At $4 million of operating losses in the third quarter corporate results were better than expected given the impact of the preferred dividend. This reflects a $3 million benefit from tax related matters, as well as $5 million of earnings from real estate operations which tend to be generated unevenly throughout the year. Adjusting for these items third quarter corporate results would have been in line with the $25 to $30 million losses we projected for the second half of the year at our second quarter earnings call.

Let me also quickly cover a couple of other items to keep in mind regarding the fourth quarter. After good performance in the third quarter the S&P 500 lost ground in the month of October. Equity markets clearly remain volatile and challenging. I also would remind you to remember that seasonally high claims experience in the fourth quarter tends to have a $5 million to $6 million negative impact on Health Division earnings.

This concludes our prepared remarks. I would now ask the conference call operator to open the call to questions.

[OPERATOR INSTRUCTIONS.]

Our first question comes with Eric Berg with Lehman Brothers.

Thanks very much. And good morning. It seems like you had an exceptionally strong service accumulation results, so congratulations to you on that.

My question, however, relates to your [GIC] business, to your GIC business and to your full service payout business. There’s nothing sort of new here in the sense that these businesses have been lagging for awhile; but I guess my question is, one, could you go over with us why the earnings in the GIC business fell as much as they did? In particular was there something beyond that, or was there spread compression in the quarter?

And I guess more importantly now that the full service accumulation business is, you know, bigger than ever how should we think about the failure to grow of these other pension businesses? I mean after all they were responsible for what I think was lack of earnings growth in your pension business overall. Is it a problem that these other businesses are not only not growing but are actually showing now declining earnings? So, what’s behind the declining earnings and is it a problem now that the earnings are declining?

Good morning, Eric. And thanks for the nice comments about the quarter. I’ll ask Larry to comment in detail on your question. Clearly, the answer is going to be environmental, it’s going to be around interest rates, it’s going to be around caps that we have on the GIC business and where we are towards those caps. But let me ask Larry to give you a little more color on the answer.

Thank you.

Good morning, Eric. This is Larry. Let me first comment on your observation around investment only. I think the best way to kind of understand what has happened in the current quarter relative to a year ago is to remember that we had record high mortgage prepayments in third quarter in ’04. And probably the rough adjustment that you want to make to the ’04 number for the GIC investment only business would be about $4 million.

I think we’ve been pretty consistent in saying that the run rate, quarterly run rate in earnings there is about $24 million, $25 million. The 22.6, the 23 million you see for the current quarter does, of course, reflect that there were not the level of mortgage prepays. And there has been a slight amount of spread compression in that business, which makes up the difference to the earnings in the current quarter.

In terms of your other question around our ability to grow those businesses, I guess the way I think about them is I think that the earnings coming out of investment only and full service payout, you know, do provide a good foundation to our overall [USAMA] earnings. Our growth in earnings out of investment only will be tied to the growth in general account as we keep the level of investment only business very close to the cap that we have from the rating agencies.

Around full service payout, that, Eric, will really depend on the defined benefit termination market sort of coming back which is going to be primarily a function of interest rates. So, we will have to see probably, you know, 50, 75 basis point higher interest rates before we see that market come back. But we do expect that to happen. We know there’s a lot of business on the sidelines.

Thank you very much.

Thanks, Eric.

Our next question comes from Jamminder Bhullar with JP Morgan.

Hi, thank you. I just have a couple of questions. First, if you could just discuss your rationale behind the redesign of the UL product? And, second, the share buyback, Barry, what’s your flexibility beyond the UBS program? I think you mentioned that it’s going to be done in November. What do you intend to do in terms of share buyback after the UBS program is over? And that’s the fourth quarter or next year?

Sure, Jimmy. Good morning. And thanks for the question. Let me ask John to remind us of what’s going on with UL. And then I’ll come back around on possible share repurchase going forward.

Sure. You may remember from prior calls when we talked about UL, the higher product that we had when we initially came out with the product it was priced appropriately to generate the return we needed. The changes in the market were driving that return down to where they weren’t acceptable returns. And the primary changes were changes in reinsurance and changes in reserve requirements. So, the new product was repriced to put it on an acceptable earnings basis based on new reserving requirements and the current reinsurance market.

Okay, but I think the changes in terms of reinsurance and also on the reserves, you knew about them for awhile, but – because my sense is that partly the Division is driven by just lower returns relative to your expectations on the old UL product. Is that true, or not?

The reserving changes really just we’re finally approved by the [NEIC] in October. We had a pretty good idea of what was coming down the road during the summer, but that was really the earliest indication.

But to be clear, I mean we did communicate earlier in the year that we had, that this block of business was not hitting our earnings expectations. We had some problems with age 70 and above, and we discontinued that. We talked about the reinsurance costs going up, and we talked about the expectation that the reserves would be increased. So, all this kind of came together and made perfect sense as to the way we need to go to get the product back to profitability.

Okay, and what are you pricing? Are you pricing the new products for how much higher in terms of ROE? Because I think in the past you were getting about close to 10 to 12% ROE on the UL product, is that right? And what are you pricing the new product for?

Yes, on the old product with all of the changes, if the new reserves would have applied to the old product it would have been down in the single-digit return.

Okay.

So, now we are up in double-digit return. And I mean it’s obviously going to depend on experience. There’s not a single number, but it’s probably in the 10 to 12 to 13% range.

On the second part of your question, we’re substantially, we will be complete by the end of November. We’re substantially there.

In terms of looking forward, I think our guidance that we’ve given you before holds true. About half of our net earnings in a given year need to be there to support organic growth. That leaves half of our earnings to be returned to shareholders, and typically about half of that or a quarter goes to dividends.

So, you know, theoretically we have about a quarter of our annual earnings that could be deployed for acquisitions, for other things. We do now have a preferred security debt to cover.

But by and large, I would say 25% is a pretty good number, but we clearly don’t want to commit. The Board has a say in this, and I would remind you that we have some debt capacity, as well. And just exactly how that plays out over time we’ll have to see. But in terms of a going forward sustainable amount is 25% of earnings, and then you’ve got to look at debt capacity, where we are at any given time.

Okay, thank you.

Our next question is from Tamara Kravec with Banc of America Securities.

Thank you. Good morning. Just a couple of quick questions. The first, the organic sales growth that you’re targeting, just so I’m clear, that includes the several large transactions that you mentioned, is that the right way of thinking of it?

Yes, Tamara, we had suggested that we believe, we said this going into 2005 that organic sales growth would be in the 10% to 12% YOY, and that would include all cases that we take over, whether they be large, small, intermediate. What it does not include is things like ABN Amerow where we go out and either sponsor or buy a whole block of business. Those are excluded from the calculation. Those are considered to be acquisition assets. But organic, those which our sales reps go out and make the contact, make the sale, those are the ones we’re talking about.

Okay. And so just looking at this quarter, I mean obviously the asset management business is clearly driving your earnings. You’ve had amazing growth in asset management, you know, some of it driven by obviously deposits. And then you've had stronger equity markets in the third quarter. And you had this lumpiness in your FSA sales. And you also said you had higher sales through alliance partners and greater demand for your offering.

So, I guess I’m just trying to get down to, you know, what is the true potential sale in this business, you know, over the next couple of years? Is it, is this sort of good as it gets in terms of sales and just growth in asset center management? And how big is big, and what is really your outlook there, because it’s such an important piece of your business?

Sure. No, that’s a good question, a fair question. If you think about full service accumulation what we’ve said, you know, when we became a public company we said we could grow this business on average over the long haul 15%. And I think if you look at the first three years our tagger was more like a 25% to 30%. It was a significant improvement.

And so we moderated growth, given where we had gone. We’d gone from $2 billion to about $5.4 billion. And so we said we think going forward organic sales, we can still achieve double-digit growth, 10% to 12% over the long haul. And we will do that this year, we will actually far exceed that this year.

And I think I gave in my prepared remarks that next year our outlook right now would be $6.4 billion to $6.7 billion of full service organic sales next year. We do not believe that we’re at a cap or that we’re saturating the market. Some of the areas of growth will continue to be total retirement solutions which is very, very hot in the market right now. And, also, a lot of room to expand with alliance partners. There are a lot of broker, dealers, financial planners and other distributors whom we have not penetrated yet. So, we still feel very good about our ability to grow this business over the long haul.

Okay. And then just on the international side. Quickly, you mentioned you had some value added products there. Can you just go into greater detail in terms of our base? Are they different than what you’re offering in the U.S.? You know, how much you’ve expanded them, and just a little bit more detail?

I’ll ask Larry to cover that for you.

Hi, this is Larry. Well, you know, our whole international strategy has been to play-off of our expertise, you know, here in the United States. So, again, we operate in markets where we think we can leverage both, you know, product wise and asset management wise the experience that we’ve had here.

Having said that, to your point, you know, every market is local. And so, for example, in Latin America you will see products that have historically had things like inflation adjustments. Now, what’s interesting is, and again, we kind of lead the market in this, we’re sort of moving from those old historical products more to the same kind of passthrough fee based products that we’re very used to here in the United States. So, it’s an example of how we kind of moved the market away from those old historical products to, quite frankly, products that we think are better for consumers, and frankly better for us as a manufacturer.

So, we’re going to continue to do that. You will see growth in these in terms of choice, much along the Morningstar style boxes we’ve seen. So, over time these markets will look more and more like the U.S.

Great, thank you.

Thank you, Tamara.

Our next question will come from Saul Martinez with Bear Stearns.

Hi, good morning, everybody. Excuse me. Two questions. One if you can give us an update on how you view your excess capital position, and what specific, how are you looking at your additional leverage capacity? Has that changed now that you’ve issued perpetual for security, which has reduced your interest coverage ratio? How should we look at your additional debt capacity, given that?

And then, secondly, any updates you can give us on your views on M&A industry wide, and any updates on your M&A strategy company specific?

Sure, Saul, I’ll be glad to have Mike comment on the first; and I’ll be glad to take the second.

Sure. Our excess capital, our position is roughly as we said last quarter, and roughly being in balance. And I say in balance being somewhere between $50 million and $100 million of excess capital sitting up at the holding company. We think about some of the activities that will go on fourth quarter, generating earnings, but a dividend payment to stockholders, probably keeping us roughly in that same balance.

In terms of debt capacity, we’re running at a debt to cap ratio of roughly 20%. It should be in that vicinity. Certainly, at the end of the third quarter and probably somewhere around there at the end of fourth quarter. Again, that’s about where we would like to run, have a little bit of cushion, a little bit of flexibility. And in terms of being able to take advantage of opportunities.

In terms of coverage, I think about sort of debt to cap and coverage of running in tandem, probably have, again, a little bit of flexibility to be able to issue more debt if we needed to, and still be within coverage ratios. So, again, I think we’re running about where we would like to run. A little bit of flexibility, and that’s good. That’s where we hope to be.

Okay.

And I would remind you, too, of our joint venture with [U.S. Bancorp]. We’ve moved some of the debt off of our balance sheet over time which would be helpful, as well.

On the M&A, I don’t think there’s much new for us to report. We continue to have a strong preference for organic growth. And I think we’re an organization that can generate organic growth. We very much like what we call strategic acquisitions, the Columbus circle, post advisory, spectrum, BCI, Professional Pensions Inc. We like to pick-up things that we can then leverage and really get a lot of synergy out of.

If you look at the macro M&A market, I don’t think our views have really changed. We will look, we will be opportunistic, but we think we have a very unique strategy, a very unique growth model, and we really like strategic acquisitions.

Great, thanks a lot.

Your next question comes from Joan Zief with Goldman Sachs.

Thank you. Good morning. I have a few questions.

The first is could you talk about the success in the full service accumulation? How much of the growth would you say is market share gains? How much is a function of the market, itself?

And then do you think that you’re going to see competitors move toward your approach to the product offerings any time soon? You’ve been so successful, as you said, with this retirement solution. So, does that bring competitors to your area of the market?

Sure, Joan, be glad to – I think Larry would be best suited to answer both of those. Go ahead, Larry.

Good morning, Joan. On the, your first question about the extent to which the full service accumulation sales reflect kind of market share growth for Principal as compared to overall market growth, the same general trends that we have commented on in the past continue to apply. About 65% of our new sales in the full service accum involve existing plans, where we take over existing plans. This is on a plan count basis. And about 35% involve brand-new plans. So, there is market share gain that is going on there. It is the majority, but there is also still, there is still about 35% of those plans that are brand-new plans.

In terms of your second question on competitors moving towards us, while we do think that our degree of integration on total retirement solutions, you know, is a very strong competitive advantage, we’re not alone in necessarily TRS. We do think that we’re very unique in our high degree of integration, and we also have the broadest platform of total retirement solutions today, because we do have DB, defined benefits, plan contribution, nonqualified and ESOP.

There’s no question competitors are going to continue to try to move towards us, but again as we’ve commented we don’t intend to stay put. We will look for further opportunities. We’ll listen to our clients. We’ll listen to our advisers. And we will over time continue to see if we can add additional solutions that are valuable to both advisers and clients to continue our lead.

Thanks. I have just one last question which is about Principal Global Investors. I mean could you help us a little, or help me, I will speak for myself, understand a little bit about what the real earnings power of Principal Global Investors is? How should I think of the what the percentage of the earnings are from transactions, the securitization gains? How much of the growth is really because you, as you say, you are adding new mandates, and it’s – you’re getting third-party fees? How much is really just related to the growth of your own internal products? And what would you suggest, I think about as a good run rate?

Sure, Joan. Jim McCaughan is here with us, so I’ll ask Jim to comment on that.

Yes. Well, thank you, Joan. Well, as Barry and Mike mentioned, the 44% YTD rise in operating earnings after tax by Principal Global Investors, the reason that supports it and the reason that just has some consistency between quarters is the total operating earnings were up 28% YTD. Total operating revenues. So that the underlying revenue earning of the Principal Global Investors business has been very strong, indeed. And in a sense we’re a much larger investment management company now than we were a year ago.

And the main part of that growth, certainly approaching three quarters of that growth was pure fee business increases, mainly from the nonaffiliate side. You can work out what we make from the affiliates simply by the change in full service assets. But we have seen the strongest piece of our growth coming from fee revenue in nonaffiliate business, which was the biggest part of that growth in operating revenues.

There were some headwinds in the securitization business during the quarter and some widening of CMBS spreads and some erosion of subordination levels, but I wouldn’t describe it as a particularly under pressure quarter, because I think by good execution we managed to counter that headwind. So, I’d regard last quarter as neither a good nor a bad quarter in the long-term trend.

And so what you’re basically saying is that you would say when you think about the earnings that you expect to generate from your securitization activity that this was a normal quarter?

It was certainly a normal quarter for the business I’ve constituted. Obviously, we have mentioned that the joint venture with U.S. Bancorp will give us a partner who can both originate and finance inventory, and help us to grow that business, and that we would then could grow the business more effectively than we could on our own which is really the rationale for doing that joint venture. So, we’re always trying to develop, but this was a normal quarter rather than an extraordinary one.

Okay, thank you.

Thank you, Joan.

Our next question comes from Colin Devine with Citigroup.

Good morning, gentlemen. A couple of questions. First, if we could look at the full service accumulation business? Obviously, the sales strength speaks for itself this quarter. But perhaps Barry, or Larry, or Mike, you could give us some guidance as to when do we see the sales growth really start to translate into margin improvement where you build on your scale and you can accelerate the earnings growth from the Division? You know, if I look YOY at the Company, perhaps Mike as well, there’s a lot of moving parts in each quarter. As you’re sitting there as CFO today, on a nominal basis, forget the EPS for a second, what do you consider the companies have grown YOY?

And then, if we can also not quite leave the UL product yet. Barry, in fact, you made a comment on the call here about returning to profitability. Is the block, in fact, that you’re to date losing money? I remember last quarter you also talked about it, right? I guess you thought you were being picked off in the over 70 bracket. You know, when you’re looking at the reserve increases what are you earning on the block of business that you’ve written to date? Is it losing money? And I guess, also, why? Is it because the regulators have just put on redundant requirements, or flat out was it just mispricing?

Good questions, Colin. I’ll ask Larry to address the first one, and let me, while he’s making a few notes, I’ll discuss the second one. And then John can jump in.

You know we are not, we’re definitely not losing money on the block of secondary guaranteed UL. As John said a few minutes ago, I think we were probably in the 6%, 7%, 8% ROE.

Why is it below the expectations that we priced it? Well, we did misprice some things. We certainly mispriced the older age, and we mispriced the way that brokers and producers would go there. We did not expect to have that proportion of our business in the older ages. And we cut that off pretty early. So, I wouldn’t say we got hurt too badly there.

We did have change in reinsurance amounts, particularly the older ages, which was an unknown. And then we were certainly expecting an increase in reserves. And I think there’s a lot of talk about those increase in reserves being retrospective and going back. I don’t think that’s going to happen, but we’ve been very cautious not to get caught with a price that wouldn’t be supported by the reserves.

So, bottom line is we’re not losing money. It’ll probably produce 6% to 8% new UL product going out is more than 11 to 13, or 10 to 13, as John said.

John, anything to add to that?

No, I think that’s a good description.

Full service cum, Larry?

Okay. good morning, Colin. Well, you know, this – the way that we think about this business, again, Colin, is one where the first thing we’ve got to have is the strong robust sales. We do feel very good about this quarter and we feel very good about our pipeline and our opportunities going forward.

You’ve seen that, as well, translate into strong deposit growth, and strong deposit growth leads to strong growth in account value which then leads to operating earnings growth. So, we think looking forward you will see as account values reach and attain and stay at that higher level you will obviously see operating earnings fall, track right along with that.

If you look back over the last kind of four quarters you’ve seen our ability to hold our return on account values has been very, very consistent. There’s been just a very, very small change in our return on account value. That is just primarily a function of perhaps a little greater percentage of assets being in separate accounts today, or mutual fund fee based accounts as compared to the general account.

We actually feel very good about our YTD growth in operating earnings, Colin. You have to remember, again, we’ve got an equity headwind, we’ve had an equity headwind here for several quarters. The third quarter was a little bit more kind, but you look over the longer term and the equity markets have been a headwind. So, again, I think it’s a very strong story. Our sales momentum and our deposit momentum should set us up for growth in account value and operating earnings going forward.

Barry, what about following up on the margin expansion question?

I don’t, Larry can answer it better than I do, but my view of this would be you’re not going to see a significant margin expansion by virtue of scale. I think the counter to that is they’re increasing amount of services you have to provide. There is increasing competition. So, in some ways by keeping it steady over these last three, four, five years it has been an expansion, because my guess is most people’s margins have deteriorated.

Yes, the way I think about it, Colin, just to add quickly on to Barry’s comments. The way I think about it is, you know, again, this is a very, very high ROE business. We’re very happy with the level of margin, profitability, and ROE we’re getting out of this business today.

And we’re quite happy to if you will sit on that and reinvest, as Barry said, in order to keep the competitive bar very, very high and make it very difficult for those competitors who want to replicate our platform. So, we’re very happy with the margins we’re sitting on today.

Somewhere, Colin, is a little bit of switcher in investment option mix by participants, so as some of the participants move from choice of guarantees which is from a dollar standpoint a higher absolute dollar operating earnings contribution to nonguaranteed separate account investment choices, somewhat lower from a dollar amount but certainly higher from a return on equity standpoint, I think that’s really helped, is one of the factors that’s really sort of muddied up as you look at sort of a dollar amount of OE trend.

Okay, and then, Mike, in your view what did the Company on a nominal basis, are earnings YOY?

Talking about sort of for the Company, or for full service accum?

For the Company’s sustainable, a lot of moving parts, ins and outs, let’s strip it all out – when you’re assessing the performance as CFO, what would you call it?

I think we can be at the, I’ll say the low double-digit operating earnings growth. And so, if you put that low double-digit operating earnings growth and put on to that some measure of share repurchase you can get to that 11% to 13% long-term earnings growth. It won’t happen ever year, some years we’ll do much better, some years we’ll do slightly worse. But I really do feel that as we have said in the past that 11 to 13% is certainly achievable, but it’s going to vary. You know, again, some years better, some years slightly worse.

And just trying to clarify, did you hit that bogey this quarter?

I would say, again, you’d have to sort of normalize things from a normal, on an optic perspective, no, on a normal perspective, yes.

Okay, thank you.

Because, again, we had very heavy prepays prior quarter.

No, I’m just trying to get the ins and outs out of here and just try to get a sense on a sustainable basis what you view earnings nominally grew YOY?

I think this was a very nice quarter.

Thanks, Colin.

Our next question comes from Suneet Kamath with Sanford Bernstein.

Good morning. I just had a question back on the FSA business, again. My understanding was that you guys were targeting 14% asset growth and then layering on 100 basis points as efficiency improvement to get to 15% earnings growth. And based on the comments that you just talked about in terms of the margin are you revising that guidance?

And then the second question is with respect to the deposits in the quarter if we go back to the second quarter I think there was this issue about some business coming in late in the quarter and sales didn’t turn into deposits. I think you usually talk about 65% of current quarter sales usually translate into deposits that quarter. Is that same phenomenon impact the third quarter results, or were you pretty much back at that 65% range? Thanks.

I’ll ask Larry to respond.

Yes, on the first one, Tanek, we still very much go by the earlier metric that we’ve communicated, where we do expect to see and, frankly, have seen that 1 to 2% operational efficiency. Again, it does get a little color to get a little muddied by a lot of the other moving parts that are going on. Things like assets moving from general accounts to separate accounts, things like mortgage prepays being high a year ago and so forth and so on.

But I can tell you that internally we have a lot of metrics around our operational efficiency, and we make sure that we are using the benefit of scale to that extent. But, again, that’s a fairly minor element of our overall OE growth. Again, the two primary drivers are going to be the equity markets themselves. Again, we ballpark that at 8, and we try to strive to get about a 5% net cash flow through organic growth, and 1% through acquisitions.

The second question was transfer business?

It was basically if the deposits from the sales kind of came in in line with, the sales in the quarter came in in line?

Yes, they did. Thank you. They did very much come in line. Along with the other point that you made that we had one sale in second quarter, very late in second quarter, where a portion of that showed up in the third quarter. But the 65% continues to be a good number.

Okay, thanks.

Our next question is from Andrew Kligerman with UBS.

Good morning. It doesn’t look like everybody did that quick one, two question. But in any event…

When you figure out how to make that happen let me know, Andrew.

Okay, I’m going to try to do two quick ones. One, the life and health return on equity, 16.5%. In the past management had actually talked about gravitating in that direction from the 20’s, and this is the first time that you’ve moved from the 20’s. You know, what’s the thinking over there?

Second, just a real quickie. ABN Amerow, you said it was breakeven yet it probably would have added 7% to assets. Should we be looking for some type of a big pickup in EPS due to the Amerow acquisition next year?

John, do you want to – obviously, that’s not the way we’re going to lower the ROE, but.

I think you’re talking about the ROE on the health portion of the business, and that is a little bit lower than what we would have expected this quarter in that we’ve got a low third quarter of this year and a low fourth quarter of last year. So, we would expect that to come up a little bit. We also put some more equity into the medical business and so that is bringing the ROE on the medical business down slightly.

So, do you think that the trend, is it going to be stable in terms of the churn, or slightly higher? And that’s what we should be thinking about going forward in the health area?

It should be slightly higher than what you saw this quarter as we roll off the fourth quarter of last year and get back to some more normal quarters we should see slightly higher than what you saw this quarter.

Probably slightly higher and somewhat stable, but not going back to the historic highs that you would see in the supplement.

Great.

On the ABN and Amerow one, just really quickly, Andrew. What I’d say is we’re very happy with how that block of business has been performing relative to our acquisition plan. As Barry commented in his remarks, we’re about 20% of the way through that conversion. We will finish that by the end of first quarter ’06.

We believe there will be some positive impact to our full service accum operating earnings in ’06, although, again, it won’t be there for the full year. So, it’ll be then in – so, you’ll see a dab of it in 2006 and another little dab of it in 2007. But, all in all, we’re very happy. We were going to finish that in September of next year. We’ve now moved that timeline to March, so that continues to perform very well.

Excellent, thank you.

Thanks very much.

Our next question comes from Thomas Gallagher with Credit Suisse First Boston.

Good morning. I’ll try and be quick with two, also, here. The first one is just on buybacks. Given the $80 million trueup on the buyback through UBS can you comment on how this changes your accretion dilution to EPS? And relatedly did you consider buying less stock given the dilution accretion breakeven analysis? And then, Barry, if you can also just comment on the pipeline for 401(k) heading into 4Q? If you said that earlier, I missed it.

Sure, I’ll let Mike take the first one, but let me go ahead and answer the one. You know, I don’t think we really did say. It continues to look very good, and I think we mentioned last quarter that the second half of the year we had pretty good visibility on it. It looks pretty good. I think our pipeline this fourth quarter as we stand today is probably 20% to 25% ahead of the fourth quarter last year.

So, we expect a reasonably strong fourth quarter. I mean that would be the case if you take what I said about we’re going to hit the, you know, we’re going to hit the number, and where we were the first part of the year and what the third quarter contributed. It tells you we’ve got to have a pretty good strong fourth quarter, as well.

Mike?

Yes, in terms of accretion dilution of the extra $80 million, really not much impact. What it will have is a bigger impact on return on equity, because obviously equity goes down by about $80 million, and accretion dilution from an EPS perspective, we’re not changing the number of shares.

Did we consider rather than settling in cash, settling in shares? We could have done that? Yes, we did. But we have some additional cash laying around the organization and so, therefore, settling in cash just made more sense to us.

And I guess, Mike, all in, do you expect this to be about neutral or is it slightly accretive when this whole program is done?

In terms of the whole program it’s probably just slightly accretive. Not incredibly accretive, maybe a penny or two a share this year, a couple $0.02 to $0.03 next year. And growing after that, so there is leverage that’s involved but near term, not much.

Okay, thanks.

Yes.

I think we’ve unfortunately run out of time. I know we probably have a few more folks in the queue. I apologize to you. Feel free to call Tom or any of us and we’ll be glad to try to get you the information.

As always, we appreciate very much your support. We are really, really pleased with this quarter. We think it sets us up very, very well for next year. We look forward to communicating with you in early December our views on how 2006 will turn out. And, again, we just thank you for your support and hope you have a great day and a great holiday season. So, thank you.

Thank you for participating in today’s conference call. This call will be available for replay beginning approximately at 1:00 p.m. Eastern Time until end of day, November 8th, 2005. The access code for the replay is 9732195. Again, 9732195 is the access code for the replay. The number to dial for the replay is 800-642-1687 for U.S. and Canadian callers. 4706645-9291 for international callers. Thank you. You may now disconnect.